Tuesday, March 24, 2009

Some time ago, the question was raised on this blog, "What happens if there is a sudden shift the current balance of demand for US treasury notes...? What if central banks decided that they no longer required as many US dollars for their international reserve?" Certain contributors (not I) were pooh-poohed for merely suggesting such a thing. Well, now it appears there is renewed reason for concern.

China's central bank, which now holds about $1 trillion in US government debt, has just called for the creation of a new international reserve currency. Citing the current crisis as clear evidence of systemic risk to the international monetary system, the People's Bank of China has proposed creating a "super-sovereign" currency for international trade and finance, regulated by the International Monetary Fund, that would represent a "basket" of other currencies. Without mentioning the US dollar by name, they say,

When a national currency is used in pricing primary commodities, trade settlements and is adopted as a reserve currency globally, efforts of the monetary authority issuing such a currency to address its economic imbalances by adjusting exchange rate would be made in vain, as its currency serves as a benchmark for many other currencies... The frequency and increasing intensity of financial crises following the collapse of the Bretton Woods system suggests the costs of such a system to the world may have exceeded its benefits. The price is becoming increasingly higher, not only for the users, but also for the issuers of the reserve currencies.

The essay was released in English as well as Chinese, which is part of what makes it noteworthy. If nothing else, at least now the G-20 finance ministers will have something else to discuss over lunch next week.

31 comments:

For the record, what was poo-poo'ed was the proposition that China would suddenly dump all its US debt with the intent of undermining the US economy.

This particular proposal of an entirely new reserve currency (actually a basket of several existing currencies along the lines of the pre-Euro European Currency Unit) managed by the IMF that China now floats was NOT brought up in the past and so was not poo pooed.

What China is proposing now is not a sudden sell off of dollars - an alarmist suggestion which I did poo poo and still do. Rather it is proposing something entirely different. China is proposing creating a new currency unit for use as a reserve currency that would be a basket of major world currencies (including the US dollar!) and would be managed by the IMF. Of course the US dominates the IMF decision making so suddenly this doesn't look that radical after all.

The real concern here is that China is evidently unhappy with the dollar and not afraid to say so publicly. While this particular proposal is less radical than it might appear and also (I would think) has little chance of going forward, it is not a good sign. What worries me is the next proposal...

Consider this. Why is China upset? They are upset because the value of the dollar is DOWN. What "certain contributers" were worried about before was that China would dump dollars. That would cause a further decline in the value of the dollar. If China is upset about the low value of the dollar, why would they do anything that would further reduce it? If anything this Chinese concern about the dollar vindicates my basic argument which is that China WANTS a strong dollar (so we will continue buying their cheap consumer goods at Walmart).

What they are proposing now is a basket currency. This has been done before. The EU did it in the 1990s in their transition to the Euro. They set up a basket of currencies in which each contributer currency was weighted by their relative importance economically. The Deutch Mark was the biggest currency in the basket and really dominated it. The Chinese seem to be proposing something similar on a global scale. Since they prose that the IMF - an organization dominated by the US - manage the proposed basket currency, it would stand to reason that the dollar would dominate this proposed basket currency.

Of course the Russians are for this. Their economy is about to go in the tank. They've been riding high on high oil prices and the world recession has caused those prices to fall. Supporting a Chinese plan that appears to blame/punish the US will make good press with the populist Russian mob.

You know how I know Russia isn't serious about this? They mentioned the UN. The UN??? Come on. The UN is designed to be incapable of dealing with controversial distributive issues.

I'll conclude by saying that even in the unlikely event that this Chinese plan gets any traction, the switch in Europe from using D-marks to D-Marks/ECU's did not really hurt the German economy. Indeed, the final switch from D-Marks/ECU's to Euros did not hurt the German economy either.

RbR: I agree we are going to pull out of this recession, and I take to heart your reminder not to be alarmist--indeed, the sky is not falling :-)

The concern is for long-term. Our national trading partners cannot turn to the international market to raise money as easily as we can, because theirs is not the preferred currency. If they succeed at some point in pushing through some sort of change along these lines, the eventual result will likely be that the US will not have such an easy time selling its T-bills. The US debt will become of greater concern then.

I don't think we should even consdier some type of "global reserve currency". That is very dangerous for the same reason that some type of "Amero" is dangerous. Not to sound alarmist, but a new reserve currency would allow bankers greater control over the financial markets. They have too much control now. It allows for greater avarice. And in the end, the political systems become irrelevant. Some would argue that this is already the case. When money interests promote selfish policies, that is what we end up with.

If this current crisis has reminded us of nothing elese, it should remind us that allowing bankers to control our economic system and overly-influence our political system through finance leads to manipulated booms and busts.

The only way we can get control over our own currency, much less some "global reserve" currency is to make the banks subject to government regulation. As it is now, the FED is completely independant of our government. We as citizens have no control over it. The IMF would not be much different because of who would run it. Citizens wouldn't be voting for IMF regulators or representatives. Already, Congress finds itself out of its depths in dealing with the fancy finances that were dreamed up here in the US and the people we are placing in charge of our resuce are the same ones who put us here to begin with.

I don't think it would solve any fundamental problems by simply starting over with some fandangled "reserve" currency. And I promise you, China would love such a thing. It would give them much more weight than they have already in global financial markets.

Some more food for thought here about who is doing the proposing and who is in trouble.

In the EU, the big push for a common currency came first from Italy and France - the two weakest currencies among the big member states. The French and Italian proponents of this move were pretty open about their goal - they wanted to simultaneously get some control over the D-mark while also using the D-mark's reputation for being a solid currency to bolster their own, unstable, currencies.

Germany resisted fiercely until 1989 when they started to have economic problems of their own. They, the Germans, also demanded a high price for their agreement to this - they control the new currency effectively. The Euro is run by a central bank the structure of which resembles the old Bundesbank much more than the French central bank (which was highly politicized and not very interested in currency stability).

China and Russia are pushing a similar plan now. Are they doing it for the same reasons? I guess what I'm asking is this: Is this really, as Dr. S. implies, a signal of long term problems for the dollar or is it a signal of the dependence of the Yuan and Ruble on the dollar?

I'd much rather be in the US economy right now than either the Chinese or Russian.

But which would you rather be? The government with the currency in a temporary down period but one which you still have some control over or a government that is totally dependent on some other currency and has no control over it. Oh, and the dependent government? They have other economic problems of their own (uneven development, over investment in real estate, over concentration of investment in one sector - oil - etc) that are going to be exacerbated by their weak position.

From a purely economic point of view (i.e. forgetting where "home" is and culture and all that stuff), which would you rather be right now, a citizen of the US, China or Russia? I don't mean to sound jingoist, I'm just asking a question about expected utility.

I just think this whole discussion about China's proposal and how it relates to America's economic future needs to be seen in that context. Why? Because a country's long term economic prospects are reflected in these kinds of questions. It will be a very very long time before the average Chinese person has anything like the standard of living of the average American - world wide recession or not.

Definitely us. Forgetting my personal prejudices for this answer, it is clear to me that America is still doing considerably better economically speaking than anywhere else--including China--and I completely agree that China has vast problems of its own.

But I feel this particular question at best somewhat misses the point, and at worst is just a distraction. I am reminded of Bob Dole, beating back any question of looming problems with our health care system by repeating, "We have the best health care system in the world." (Note: I was just trying to paint a funny image here, I'm not actually making a serious comparison. And for the record, RbR is much wiser than Bob Dole.)

RbR writes, "I'd much rather be in the US economy right now than either the Chinese or Russian." And I agree. Right now. But what about the future? The sky is not falling, true, but is it so wrong to observe with concern that there appear to be a few more cracks now than there used to be?

To me, the real question is: just how important is this currency concern anyway? RbR has provided quite a number of good reasons to believe it is not very important. And I am certainly not going to lose any sleep over it.

Nevertheless, with a worldwide economic slowdown triggered by the bursting of the US housing bubble, with US budget deficits spiraling into the trillions, and with a certain lingering unpopularity of US foreign policy, we are more vulnerable than we have been in quite a while. If the international community decides it is time to dethrone the dollar, for political reasons if not economic ones, there will be unpleasant consequences for the US. Our trading partners are not about to take any such action yet, but don't we ignore them at our peril?

I think the Obama plan is the right way to go: investing in health care, education, and energy. This holds the best chance of maintaining our edge in productivity and all that good stuff.

Yep, you ignore trading partners at your peril. One thing we're hearing in Aus - said by reliable, rational sources - is how unfair it seems that the US has created the financial crisis (essentially), yet the US dollar is still seen as a safe haven, and thus the US dollar isn't suffering as some other currencies are now. If enough countries start thinking the same way, hello dethronement.

Well, it's a bit too easy for Australians and Europeans to blame the US alone for this one.

The real estate bubble was global and actually a lot worse in some countries than it was in the US. Sure the US banks were monkeying around with some funky new financial schemes but the reason this is going world wide is because everyone else's banks joined the party too.

A note on "hello dethronement" and similar anti-American sentiments. This is a popular and oft stated wish among the yuppie-left of Europe and other rich countries. But it is worth pointing out that "dethroning" US hegemony may not be desirable for most of the rest of the world let alone imminent.

The standards of living in countries like Australia are largely supported not just by their trade with the US economy but also by policies pursued by the US globally. American emphasis on things like freedom of the sea lanes and free trade are a direct support to the economies of countries like Australia.

If you talk about "hello dethronement" with such obvious glee you should stop and think about the likely replacement. A kind of UN utopia is not the likely alternative. World wide economic depression and war is.

Another oft proposed alternative is Chinese hegemony. But I would be very wary of thinking Chinese hegemony would benefit countries other than China nearly as much as US hegemony has benefited countries other than the US. Furthermore, I'd bet that if China's current government were in the same position the US government is in now, it would be far less responsive to the world outside its borders than even the American leaders are.

Be careful what you wish for down-under. It can fun to poke the Americans in the eye for entertainment value and to distract the masses from their own problems, but if you are serious about it, think seriously about the consequences and alternatives.

I'm more and more convinced that this is a much stronger signal of long term weakness by the Chinese economy than a play to supplant US leadership in the world.

The fact that the Russians were the first (and only?) country to jump on this bandwagon is a strong indication to me that this is a plan to get the US to bail them out rather than a plan for them to take over.

RbR: Pombat merely observed that--thanks to the worldwide financial crisis triggered (essentially) by the collapse of the US real estate bubble--those grumblings against reliance on the US dollar that concern me are starting to be echoed by reasonable people in friendly nations. Thus we ignore them at our peril.

There was no glee--and certainly no "obvious" glee--anywhere in Pombat's brief response. Nor did Pombat express any sentiments even remotely anti-American. In fact, Pombat expressed no wish for such "dethronement" at all.

In truth, the only hateful speech I read here is the poisonous anti-European, anti-Australian sentiment coming from you.

Thanks Dr.S, good to see someone here is coming from a rational basis, rather than leaping to see anti-Americanism in everything not overtly pro-American.

RbR: for the record, Dr.S is spot on - I was merely making an observation. For future reference, "obvious glee" would have looked like this: "hello dethronement :-))) :-D :-)))".

Furthermore, I am well aware that other countries' banks and real estate markets joined the party too (which I have been quite vocal against on more than one occasion), I am aware that the utter collapse of the US dollar would have worldwide ramifications, and I am aware that various US policies assist trade here in Aus. It's kinda nice, not being stupid.

FYI, our standard of living, particularly recently, has been greatly supported by the Chinese desire for resources, and our related mining boom. Which I suppose does eventually translate to trade with the US economy, since the US is purchasing the bulk of the stuff China is making with the help of those resources, but still - China's economy is being watched closely by people here, not just the US economy.

What anti-European or Anti-Australian sentiments? I merely pointed out - accurately - that non-US rich countries owe a great deal of their standards of living to the existence and position of the US. It is a fact that the US, Europe, Australia, and China are all interdependent. I have said as much repeatedly. The point I am making is that the US position as "hegemon" protects a global arrangement that benefits all these countries. At the same time, it's not a US dictatorship or imposed solely by military might. So "...throne..." is perhaps an unfortunate choice of words.

The use of the term "hello dethronement" is dripping with implications suggesting a world view that: a) the US is responsible for problems b) that the US rules the world like a monarch c) that the rest of the world is absolved from responsibility because of that. d) the little countries may rise up and rebel against the US. To suddenly back off the implications of that kind of statement and feign outrage when called on it - not to mention Dr. S. trying to turn it around and blame me for being on some xenophobic rampage for pointing out the interdependent relationships - is a little disingenuous.

I'll add that I strongly object to the implications of both Dr. S. and Pombat that there should be some sort of American "alleinschuld" for this financial crisis.

I'm glad to see that Pombat is backing off this position now. Where before she said, "how unfair it seems that the US has created the financial crisis (essentially), yet the US dollar is still seen as a safe haven" she is now saying "I am well aware that other countries' banks and real estate markets joined the party too (which I have been quite vocal against on more than one occasion), I am aware that the utter collapse of the US dollar would have worldwide ramifications, and I am aware that various US policies assist trade here in Aus. It's kinda nice, not being stupid."

Those are two very different kinds of statements. I agree with the second one. But the second statement is in fundamental disagreement with the first.

Firstly, I used "dethronement" because Dr.S had used "dethrone the dollar" in a previous post, in the context that other countries might decide that they want to do that (which seems like a valid worry to me). It was not "dripping with implications" - those "implications" are entirely in your mind.

Secondly, my "first comment" about "how unfair it seems...safe haven" was said in the context of this is what we're hearing in Australia - I am reporting to you in the US viewpoints from another bit of the world that I'm assuming you are unaware of. At no point did I say that that was my personal viewpoint.

Thirdly, and lastly, I am sick and tired of you twisting comments to claim that I'm being anti-American. I am not intrinsically anti-American, which is to say I am not against things purely because they are American. I am however anti a lot of things that happen to coincide with an American way of doing things, for example rampant consumerism (I remember a post from last year sometime when you were boasting about your new only-$400 audio/multimedia/whatever system, and asked "how good is that?", to which my response was "is it really good?" - apologies if I've not remembered the exact words used, I do remember not receiving a reply).

So quit accusing me of being anti-American simply because I chose to give you what I thought would be received as a valuable insight into what's going on elsewhere in the world.

No one is feigning outrage here, RbR. I am outraged. I am totally outraged by your comments on this thread. Please consider that at least in this instance I might not just be a crazy person. This is important.

If you truly believed the phrase "hello dethronement" was dripping with all those imaginary anti-American implications, then you screwed up the context. That phrase CLEARLY referred to the reign of the dollar as the dominant global currency--not the alleged reign of the United States as a global monarch. As Pombat says, everything else you read into that phrase came from you. You owe Pombat an apology--and a real apology, not a fake one of the, "I'm sorry you got offended," variety.

The only person dropping sarcastic little phrases "dripping with implications" here is you, RbR. You're the one who invoked, "the yuppie-left of Europe and other rich countries." You're the one who accused our friends "down under" of poking Americans, "for entertainment value and to distract the masses." You're the one who mocked me for allegedly advocating a "UN utopia."

I intended my response to the remarks to be in the context in which they were given. I did get that Pombat was talking about what she hears around her with respect to the "dethronement" bit. But I missed that this was a quotation of others with regard to the "unfair" bit. In any case, I was trying to respond to those comments themselves - which were expressed by people who I presumed to have the views I noted. So, no Pombat, I did not intend to accuse you personally of being anti-American. Nor do I think I said, "Pombat you are anti-American." Indeed, I intended "careful what you wish for down under" to be a vague, general and blanket comment to those unnamed sources who made the comments Pombat reported. That said, I think I'm on safe ground to assume that many of the people she was hypothetically quoting do intend those kinds of comments to be in some measure anti-American.

On the UN utopia, that was not directed at any one comment specifically let alone at Dr. S. personally. Rather it was directed a commonly proposed alternative to US hegemony.

As for the "yuppie left" comment. Come on. We're all yuppie leftists here. We all make more than our respective countries' median incomes (I'm assuming and I think it's a fair assumption), we're all young - well, youngish - and we're all politically left of center. And again, I think I'm fairly safe ground here that if we analyzed anti-American sentiments in Europe and other rich countries they would correlate with higher income young people who vote on the left.

I was taken aback by the outraged responses to my response. I really did not intend my responses to be a personal attack on either Pombat or Dr. S. but rather an aggressive response to a category of arguments raised either by them or referred to by them as being raised by others. Namely:

The US caused the current world economic crisis.

The current economic conditions in the US are an indicator of a collapse of US leadership in the world (and that this would in some sense be desirable or more fair).

[The goodly gnomes at blogspot just ate my previous attempt to respond... Which is probably for the best. Sometimes life manages to provides both catharsis and serendipity.]

You say this was all just a big misunderstanding--so I guess I'll just ask you to be more careful when you share your thoughts on anti-Americanism in response to our foreign friends. I value their insights and I really would like them to feel welcome here.

I find China's proposal amusing. What China is saying, of course, is that they'd rather not rely on the dollar, but there's obviously no better place to put their money. So, glumly, they are stuck with the dollar.

And this is how it will remain. The Euro is simply too new to be the reserve currency of choice. In hard times, you never know if the EU is going to split up or become moribund. It's a nonzero risk higher than that of US default. After all, if required to put $1000 worth of your own money on a bet as to whether the EU currency system or the US currency system will collapse, nobody would bet on the euro. Germany could withdraw from the euro and survive, if battered - New York can't withdraw from the dollar.

A UN-based currency would be even less trustworthy in the long run. Five states with vetos over a central bank? Craziness.

What the Chinese and Russians resent is that in a global economic market, they have less control over their own currency and their own economic future than they did as autarchic societies. Well, that isn't going to change.

(I think it was an IMF-based currency rather than a UN-based currency. Not that the difference staggering, or anything.) But at any rate, is there anything regarding the currency situation that does give you cause for concern?

There are some important institutional differences between the UN and IMF. The UN security council makes decisions by unanimity among the US, Britain, France, Russia and China. The IMF makes decisions by qualified majority using a system of "bloc votes" in which countries get a number of votes related to the size of their economy. The US bloc of votes is sufficient to veto any decision. No other single country has a sufficient bloc of votes to do that.

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